Transfer pricing workshop cairo 14 25 february 2010
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Transfer Pricing Workshop Cairo 14-25 February 2010. Intra-Group Services Management Fees Cost Contribution Arrangements (CCAs). Types of Intra-Group Services. Administrative, technical, financial and commercial services for a specific group member

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Transfer Pricing Workshop Cairo 14-25 February 2010

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Transfer pricing workshop cairo 14 25 february 2010

Transfer Pricing WorkshopCairo14-25 February 2010

Intra-Group Services

Management Fees

Cost Contribution Arrangements (CCAs)


Transfer pricing workshop cairo 14 25 february 2010

Types of Intra-Group Services

  • Administrative, technical, financial and commercial services for a specific group member

  • Management, coordination and control functions for the whole group


Types of intra group services

Types of Intra-Group Services

  • Intra-group services usually include services ordinarily performed internally (central auditing, financing advice, training of personnel)

  • Often include services that are typically available externally from independent enterprises (such as legal and accounting services)


Typical arrangements

Typical Arrangements

  • Parental service arrangements

  • Centralised service companies (group service centre)

    • Cost centre

    • Profit centre

    • Specialized service centres

  • Cost contribution/sharing arrangements


Typical arrangements1

Typical Arrangements

Parental services

  • Provided by the parent company – often on cost recovery basis, i.e. with no profit element.

  • Examples are:

    • Group finance

    • Group tax

    • Legal


Parental services

Parental services

Provision of services

Management fees


Typical arrangements2

Typical Arrangements

Centralised services

  • Provided by a service company in the group – usually on a cost plus basis, i.e. including a profit element.

  • Examples are:

    • IT support

    • Technical

    • Finance and treasury


Centralised services

Centralised services

Provision of services

Management fee


Typical arrangements3

Typical Arrangements

Cost contribution/sharing arrangements

  • Provided by each group member for the benefit of the group as a whole always on a cost contribution basis commensurate with (expected) benefit.

  • Examples are:

    • Research and development

    • Procurement


Transfer pricing workshop cairo 14 25 february 2010

Cost contribution arrangement

Provision of services

Allocation of costs


3 key issues re intra group services

3 Key Issues re. Intra-Group Services

  • Determining whether an intra-group service has been rendered

  • Identifying actual arrangements for charging for intra-group services

  • Calculating the arm’s length price


Rendering of intra group services

Rendering of intra-group services


Rendering of intra group services1

Rendering of intra-group services

  • Activity performed must provide to the recipient with economic or commercial value o enhance its commercial position.

  • Consider whether an independent enterprise would:

    • Pay for the activity if performed by an independent enterprise; or

    • Perform the activity in-house

    • If not, no intra-group service


Rendering of intra group services2

Rendering of intra-group services

  • Existence of an actual payment is useful, but does not prove that the service has been actually rendered

  • Notation of “management fee” is notprima facie evidence of management services

  • Absence of payment does not necessarily mean that no services have been rendered


Rendering of intra group services3

Rendering of intra-group services

  • Types of services:

15


Rendering of intra group services4

Rendering of intra-group services

  • Activities not constituting services:


Rendering of intra group services5

Rendering of intra-group services

  • Shareholder activities:

    • Costs related to juridical structure of the parent company itself

    • Costs related to reporting requirements of the parent

    • Costs related to raising funds for the acquisition of its participations.


Rendering of intra group services6

Rendering of intra-group services

  • Duplicative services:

    • Covers those services already performed by the recipient or by an arm’s length party on its behalf.

    • However, duplication could be accepted under certain circumstances, e.g. temporary duplication.


Rendering of intra group services7

Rendering of intra-group services

  • Incidental benefits:

    • Covers services performed by one group member (e.g. shareholder or coordinating centre) for a particular group member or a set of group member, and incidentally provides a benefit to other group members.

    • OECD examples in para. 7.12 - 7.13


Rendering of intra group services special considerations

Rendering of intra-group services special considerations

  • On call services

    • Use frequency

    • Degree of benefit obtained.

    • Consider facts and circumstances.

  • Aggregation/segregation

    • E.g. higher price for products because R&D is embedded in the product, rather than a separate service charge.


  • Rendering of intra group services8

    Rendering of intra-group services


    Allocation of costs

    Allocation of costs

    • Management fees charged as percentage of sales of the service recipient, e.g. 5% of the sales of the service recipients, possible?

    • Management fees should be based on the cost of service rendered

      • Actual vs. budgeted cost

    • Value added strategic services v. routine support services and low margin services


    Allocation of costs1

    Allocation of costs

    • Direct cost allocation

    • Indirect cost allocation


    Allocation of costs2

    Allocation of costs

    • Direct cost allocation

      • Group members are charged for specific services

      • Identify the costs incurred for a particular service to a specific affiliate.

      • Provides greater transparency to the tax authorities

      • Costs and time associated with supplying the services will be straightforward to identify

    • Examples:

      • R&D performed by central R&D department for a specific company or client

      • Marketing from the central departmentprovided for a specific market or region

      • Trademark violation in a specific market that was dealt by the legal department


    Allocation of costs3

    Allocation of costs

    • Indirect cost allocation

      • Used where proportion of the value of services rendered to each entity cannot be exactly quantified

      • Identify all relevant costs and allocate them among all recipients using a sensible allocation key/keys

      • Indirect cost allocation method must:

        • Be sensitive to commercial features of individual case

        • Contain safeguards against manipulation

        • Follow sound accounting principles

        • Produce allocations of costs that are commensurate (in proportion) with actual or expected benefit of service recipient


    Cost allocation keys

    Cost allocation keys

    An indirect charge method may need some adjustments to achieve an arm´s length price. Combination of allocation keys is sometimes useful.

    26


    The arm s length price

    The arm’s length price

    • Consider perspectives of both

      • Service Provider and

      • Service Recipient

    • Provider

      • How much does the service cost?

    • Recipient

      • How much is the service worth?

      • How much would it cost to provide the service in-house?

      • How much would an external service provider charge?


    The arm s length price1

    The arm’s length price

    • Arm’s Length Price Setting

    Minimum price acceptable for provider

    Maximum price acceptable for recipient

    Range of

    AL prices


    Applicable transfer pricing methods

    Applicable transfer pricing methods

    • Chapters II and III OECD TP Guidelines:

      • Comparable Uncontrolled Price (CUP)

      • Cost Plus

      • Combination of methods or TNMM


    Applicable transfer pricing methods1

    Applicable transfer pricing methods

    • CUP

      • Preferable when:

        • There is a comparable service provided between independent enterprises in recipient’s country

        • The associated enterprise providing the service also renders it to independent enterprise in comparable circumstances.

      • Examples: accounting, auditing, legal or computer services being provided.

      • Careful! Service infrastructure might impact the price!


    Applicable transfer pricing methods2

    Applicable transfer pricing methods

    • Cost Plus Method

      • Applicable in the absence of a CUP where activities, assets and risks are comparable

      • Cost base is very important (often more material than mark-up)

      • Mark-up: special considerations


    Cost plus method

    Cost Plus Method

    • Cost Plus (Profit) Mark-up?

      • Normallymark-up (comparisonwith independent enterprises)

        • Factors to consider: nature, significance of the service, efficiency of the service supplier…

      • In some cases no mark-up required (OECD Guidelines paras. 7.33 - 7.37):

        • Group enterprise acting as an agent or intermediary

        • The costs are already equivalent to the market price

        • Unreasonable administrative burden

        • Safe harbours for service mark-up in some countries


    Cost plus method1

    Cost Plus Method

    • Cost Plus (Profit) Mark-up?

      Speaking Notes continued


    Cost plus method2

    Cost Plus Method

    • Cost base very important

    • Cost base often more material than mark-up

    • Functional analysis important – take into account both immediate and long-term impact of service

    • Example in OECD Guidelines para. 7.36: mere intermediary/agency service – profit mark-up limited to intermediary/agency activities


    Transfer pricing workshop cairo 14 25 february 2010

    Intra-Group Services

    Procedure:

    Step 1: Which services have been performed?

    Step 2: Identify shareholder´s activities

    Step3: Determine which income or cost to be charged

    Step4:Determine the arm´s length price or “service fee”

    Step 5:Identify costs that could be charged directly

    Step 6:Determine allocation key for charging indirect costs

    Step 7:Put together the total base of allocation


    Cost contribution arrangements

    Cost Contribution Arrangements


    Cost contribution arrangements cca

    Cost Contribution Arrangements (CCA)

    • Framework agreed among business enterprises to share the costs and risks of developing, producing or obtaining assets, services, or rights, and to determine the nature and extent of the interests of each participant in those assets, services, or rights.

    • A contractual arrangement rather than a judicial entity or permanent establishment

    • CCA should exist prior to development of the asset/service


    Cost contribution arrangements examples

    Cost Contribution ArrangementsExamples

    38

    • Joint development of intangibles – each participant receives a right to exploit the resulting IP

      • Legal ownership versus economic ownership

      • No royalties

    • Joint provision of services that each entity provides and receives

      • Separate service company rewarded on an arm’s length basis – generally not a participant

      • Acquisition of property for mutual use


    Cost contribution arrangements cca1

    Cost Contribution Arrangements (CCA)


    Key issues in cca

    Key issues in CCA

    • Participants

    • Contributions vs. benefits

    • Ownership

    • Amount of participant’s contribution

    • Buy-in/Buy-out payments

    • Termination

    • Non arm’s length character of CCA

    • Structuring CCAs


    Participants

    Participants

    • Participants: entity with a reasonable expectation that it will benefit from the CCA activity itself.

    • Exploitation and use can be done directly or indirectly

    • Question: Participants to a CCA may engage a separate entity to perform part of all of the activities is this separate entity a participant in the CCA?


    Transfer pricing workshop cairo 14 25 february 2010

    CCA: Contributions vs. Benefits

    - Participants’ Shares -

    • In a CCA, each participant’s proportionate share of the contributions to the arrangement must be consistent with his share of expected benefits.

    • Each participant would be entitled to exploit its interest, without paying a royalty or other compensation.

    • In a CCA there is always an expected benefit that each participant seeks from his contribution; his interest in the results of the CCA activity should be established from the outset.

    Joint development of a new product and intangible property derived from it

    A typical CCA


    Transfer pricing workshop cairo 14 25 february 2010

    CCA: Contributions vs. Benefits

    - Illustration -

    Participant

    Contributions Benefits

    CCA

    Contributions Benefits

    Contributions Benefits

    Participant

    Participant


    Transfer pricing workshop cairo 14 25 february 2010

    Contributions vs. Benefits

    44

    • Benefits may be known in advance or uncertain, e.g. R&D

    • Some may be immediate, e.g. services or over a longer term, e.g. R&D

    • Always expected benefit

    • Skills are pooled and the consideration is towards the reasonable expectation of mutual benefit

    • Similar to a Joint Venture

    • However, the activity does not need to be successful


    Ownership

    Ownership

    • Each participant’s interest in the results of a CCA activity should be established from the outset, even where the interest is interlinked with that of other participants

    • Participants in the arrangement jointly own the developed asset No need to pay a royalty for the use of the asset/service

    • Legal v. economic ownership:

      • Multiple beneficial or economic owners

      • Usually, one legal owner, e.g. because legal ownership of developed intangible property is vested in only one of them but all of them have effective ownership interest.


    Amount of participant s contribution

    Amount of participant’s contribution

    • Under the arm’s length principle, the value of each participant’s contribution should be consistent with the value that independent enterprises would have assigned to that contribution.

    • Use of cost and market prices as measuring tool

    • Requires case-by-case determination


    Amount of participant s contribution1

    Amount of participant’s contribution

    • Is the allocation appropriate?Objective: estimate the shares of benefit to be obtained by each participant and allocate contributions in the same proportion

    • Estimation of benefits (projections!):

      • Anticipated additional income generated

      • Anticipated costs saved

    • Price charged in sales of comparable assets and services

    • Allocation key or combination of allocation keys

      • Sales; units used, produced, or sold; gross or operating profit; number of employees; capital invested; etc.

    • Adjustments to allocation keys may be necessary!


    Amount of participant s contribution2

    Amount of participant’s contribution

    • Contributions can be in cash, property and services

    • Sometimes difficult to assess the participant’s contribution of property and services to the CCA or subsidies and tax incentives


    Transfer pricing workshop cairo 14 25 february 2010

    Amount of participant’s contribution

    Balancing Payments

    49

    • A participant may be required to make a payment to other participants to adjust its proportionate share of contributions

    • Balancing payments are used to maintain the arm’s length nature of the CCA

    • They do not constitute a royalty for the use of the intangible

    • Generally treated as a cost to the payer and a reimbursement to the recipients


    Buy in buy out payments

    Buy-in/Buy-out payments

    • Buy-in/buy-out payments should reflect the value of current intangible property owned

    • Buy-in payment: payment made by a new entrant to an existing CCA for acquiring an interest in the results of prior activities of the CCA

    • Buy-out payment: payment made to a departing member of an existing CCA

    • Payments must be arm’s length!


    Cca termination

    CCA termination

    • Each participant receives a beneficial interest in the results of the CCA activity consistent with its proportionate share of contribution,

      or

    • A participants could be compensated by one or more participants for surrendering its interest in the results of the CCA


    What if a cca is not arm s length

    What if a CCA is not arm’s length?

    • When the consideration received by a participant is inadequate, and that received by another participant is excessive…

      • The arm’s length principle requires an adjustment (often through a balancing payment)

      • In some cases, part or all of the terms of a CCA may be disregarded if commercially the substance (reality) differs from the form


    Recommendations for structuring ccas

    Recommendations for structuring CCAs

    A CCA at arm’s length normally would meet the following conditions:

    a)Participants include only enterprises expected to derive benefit from the CCA activity itself.

    b)Arrangement specifies the nature and extent of each participant’s beneficial interest.

    c)No payment other than CCA contributions, balancing & buy-in payments made for the beneficial interest.

    d)Proportionate shares of contributions determined in a proper manner.

    e)Arrangement allows for balancing payments or for the allocation of contributions to be changed prospectively.

    f)Adjustment made as necessary upon entrance, withdrawal and termination of the CCA.


    Examples

    Examples


    Example 1

    Example 1

    • AusCo. Is a member of a MNE group

    • AusCo. Manufactures and sells the products itself and has licensing arrangements with other group members to use the technology to manufacture the products for sale in their local markets

    • AusCo is about to commence intensive R&D to enhance the technology for the next generation of the products

    • The risk of this R&D being unsuccessful is considered relatively low

    • AusCo has the necessary resources, expertise and financial capacity to perform the R&D and exploit any new technology produced.


    Example 1 cont d

    Example 1 (cont’d)

    • The MNE board decides that the new R&D will be performed under a CCA, together with ForCo, a newly established non-resident group company.

    • AusCo's contributions will be in the form of existing technology and ongoing R&D services

    • ForCo's contributions will be cash. In return, ForCo will have the right to license the new technology to group members other than AusCo to manufacture the product for sale in their local markets.


    Example 1 cont d1

    Example 1 (cont’d)

    AusCo.

    ForCo.

    License to group members

    Cash

    Existing technology + ongoing R&D services

    CCA

    Technology development


    Example 2

    Example 2

    • Ausco, parent ForCo and several affiliates are members of a MNE group operating in automotive industry.

      • Each produces vehicles for sale in local market

      • Each operates its own R&D centre responsible for all aspects of design and technology for its locally produces vehicles

  • Technology information is contained in a database to which all members have unlimited access

  • Any centre may use technology developed by other centres

  • Costs and risks of operating the R&D centres are pooled and shared amongst the participants based upon expected benefits from use of R&D results in the production of vehicles


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